How to Choose a Life Insurance Policy

Learn how much you need, plus the pros and cons

Choosing a life insurance policy can be overwhelming because it forces us to think about something we really don’t want to happen: the effects on our family or loved ones once we die. Then, there are all the options and the added cost.

As of 2020, only 54% of adults have some form of life insurance. That's down 9 percentage points over the last decade. But life insurance can help you be prepared for the worst. Learn the basics about how to choose a life insurance policy without breaking the bank so you can get the protection you need.

What Is Life Insurance?

Life insurance is a contract between an insurance company and yourself in which you agree to pay a premium in return for the insurance company’s commitment to paying a set amount of money to a person(s) of your choice upon your death.  

The money the insurance company agrees to pay is known as the death benefit. The person who receives the money is the beneficiary.

Why Should I Get Life Insurance?

The main reason to get life insurance is to secure a lifestyle or wealth for your family (or a chosen beneficiary) after you die. There are other advantages as well. A few common reasons to get life insurance include:

  1. Paying for funeral expenses, unpaid medical bills, student debt, or other debts remaining after death so that your family does not need to assume the burden
  2. Leaving money behind to your family or spouse so that they can maintain the lifestyle they were accustomed to
  3. Leaving an inheritance, donating funds to a charitable cause, providing funds for college, or paying off a mortgage
  4. Building wealth, as can be seen when using life insurance with investment options
  5. Transferring wealth and taking advantage of various tax breaks for the beneficiary when receiving the death benefit—life insurance can provide many tax-free advantages
  6. Paying for estate taxes so your family does not have to use the inheritance to cover these taxes
  7. Securing a mortgage or other debt when the lender requires it

Types of Life Insurance Policies

There are two main categories of life insurance: term life insurance and permanent life insurance.

In the term life insurance category, you may choose life insurance for a specified length of time, which is known as the term. With permanent life insurance, the length of the policy is for life (some companies may also offer the plans to age 65).

While you really only have one option for term life insurance, there are two types of permanent life insurance:

  • Term life insurance: Purchased for a specific length of time, usually between 10 and 30 year terms, with no cash values, and expires at the end of term, unless it is “convertible.” This is the least expensive life insurance option.
  • Whole life insurance: Has a set premium and is valid as long as you keep paying the premiums. This is a type of permanent life insurance. It may build up cash value and if you surrender the policy, it may be returned to you.
  • Universal life insurance: Also a type of permanent life insurance, this kind offers investment options. Premiums may be adjusted over time based on how you decide to manage it. Factors include your investments, cash values, and other options such as borrowing from your life insurance policy.

People often assume that they need to choose between one type of life insurance policy or another, but consider the option of leveraging both types of insurance in your favor. It may be a better financial option for you to use a combination of both term and permanent life insurance because your needs will vary as you age.

Convertible or Combination Life Insurance

Combination life insurance policies give you options to have a payout in circumstances other than just death. It is now becoming more popular for people to choose a life insurance policy that combines with other coverage, such as long-term care insurance. In fact, a 2019 study by Life Happens and LIMRA found that one in five Americans stated they would be very to extremely likely to buy a combination product.

Convertible life insurance policies allow you to start off with a term life insurance policy and convert it to a whole life policy instead of losing the policy at the end of the term. This may prevent you from having to take a medical exam when you convert to whole life. 

Pros and Cons of Life Insurance

Pros
  • Financial security and peace of mind for your family or spouse

  • Flexibility to use the funds from life insurance as the beneficiary sees fit

  • Fixed premiums so you know what to expect in your budget

  • Permanent life insurance offers the possibility of building savings through investments (may also allow the option of borrowing money from the life insurance policy later in life if needed)

Cons
  • For term life, after the term is up if the death benefit is not paid, any premiums paid into the policy are lost

  • For whole life with cash values or universal life, investment options do not yield the highest possible returns

  • If you do not pay the premium, your policy will be canceled and you may have to take out a new life insurance policy, subject to your current age and a new medical exam

How Much Life Insurance Do I Need?

Since people will buy life insurance for various reasons, how much you need will depend on why you are buying it. If you are looking to secure the financial well-being of your family should you die unexpectedly, then you will need to review various personal factors to help you figure out how much you need.

For example, how much income would your family need per year to replace your lost income? Keep in mind that when you are alive, part of your income goes to sustaining your own needs and activities, so if your income was $75,000, but you used a portion for your own consumption, you may want to consider that. Also, if you cover your mortgage in the death benefit, would a portion of your income have gone to that? These factors can reduce the amount of income you need to replace.

The answer to income replacement is not always straightforward, so consider these questions and more carefully:

  • How many years would you need to provide income?
  • If you have a spouse, would they work after your death? How much income do they make to contribute to family expenses? How long will they work?
  • Do you need to provide funds to be used for education, like college?
  • How much debt does the family (or you) have? Do you want to cover this in your life insurance? Are there outstanding loans, medical bills, or mortgages?
  • What would your family’s expenses be as a result of your death? Consider funeral expenses, costs of hired help at home, and more.
  • What investments and savings do you have?


How Much Does Life Insurance Cost?

Life insurance can be as inexpensive as a few dollars a month to several hundred. Most life insurance companies offer various payment options to help make payments affordable. However, 44% of millennials overestimate the cost of life insurance, which may feed into the growing hesitation to get it.

The cost of life insurance will depend on a few factors such as:

  • Age
  • Medical conditions or health, including if you are a smoker or not; you may have to pass a life insurance medical exam to be eligible for life insurance
  • The amount of the death benefit
  • The term of insurance: permanent life insurance is significantly more expensive than term life
  • Whether or not the policy has a cash value or not

Overall, the younger and healthier you are, the less expensive life insurance is.

Key Takeaways

There are a lot of options to choose from when deciding on what kind of life insurance you need. Your age and personal situation will dictate what the most needed life insurance coverage is for you, as well as how much you can afford.

  • Consider that term life insurance can be used for short term needs in combination with convertible or permanent life insurance options to save money, especially when you are starting out.
  • Always review your life insurance choices every few years or whenever your family situation changes, including the amount of the death benefit and who the beneficiaries are.
  • Getting the opinion of licensed life insurance or financial advisors when you are making your choice is strongly recommended because it can help you find ways to afford the right kind of coverage and ensure you don’t end up going without life insurance because you are worried about the costs.

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